By Pam Martens and Russ Martens: May 20, 2016
Wall Street On Parade has learned, by piecing together the SEC filings of Freddie Mac and Fannie Mae and previous Federal Reserve studies, that these two companies that have been in U.S. government conservatorship since the 2008 financial crisis, continue to pay out billions of dollars to the biggest Wall Street banks on their derivatives contracts.
This raises multiple red flags, not the least of which is how much does the U.S. public really understand about the 2008 financial crisis and what appears to be a continuing taxpayer bailout. It is well known at this point that AIG had to be bailed out because it owed over $90 billion on its derivative and security loan contracts to Wall Street and foreign banks. Now, it’s looking like Fannie Mae and Freddie Mac were also Wall Street’s derivatives patsies – or “dumb tourists” as author Michael Lewis might say.
According to Freddie Mac’s first quarter 10K filed with the Securities and Exchange Commission, this is how much it has paid to its derivatives counterparties in just the past four years: $2.1 billion in 2015; $2.6 billion in 2014; $3.46 billion in 2013; and $3.8 billion in 2012. Fannie Mae’s payouts have been smaller than Freddie Mac’s.
We could not find comparable data for Freddie Mac for the crisis years but its 10K for the first quarter of 2011 shows total derivative losses (declines in the value of its derivatives portfolio plus payouts to counterparties) as follows: $8 billion in 2010; $1.9 billion in 2009; and a stunning $14.95 billion in 2008.
Both the Federal Reserve Bank of New York and the Federal Reserve Bank of St. Louis have conceded in separate studies that placing Freddie and Fannie under U.S. government conservatorship was critical to stemming the bleeding of the big Wall Street banks because of their derivatives counterparty status. The New York Fed’s staff report of March 2015 noted the following:
“Fannie Mae and Freddie Mac held large positions in interest rate derivatives for hedging. A disorderly failure of these firms would have caused serious disruptions for their derivative counterparties.”
A 2010 report from the Federal Reserve Bank of St. Louis backs up the New York Fed’s more recent assessment, noting:
“The failure of Fannie and Freddie would have led to a winding down of large quantities of swaps with the usual systemic consequences. The mere quantity of transactions would have led to fire sales and invariably to liquidity funding problems for some of Fannie and Freddie’s OTC counterparties. Moreover, counterparties of Fannie and Freddie in a derivative contract might need to re-intermediate the contract right away, as it might be serving as a hedge of some underlying commercial risks. Therefore, due to counterparties’ liquidating the existing derivatives all at once and replacing their derivative positions at the same time, the markets would almost surely be destabilized due to the pure number of trades, required payment and settlement activity, and induced uncertainty, and the fact that this was taking place during a crisis.”
Why do we believe the derivatives counterparties to Freddie and Fannie are the big Wall Street banks? Because according to the Office of the Comptroller of the Currency’s 2015 fourth quarter report on derivatives, the following Wall Street banks are holding over 90 percent of all derivatives: JPMorgan Chase, Citigroup, Bank of America, Goldman Sachs and Morgan Stanley’s bank holding company.
On May 11, we asked Freddie Mac’s media relations department to provide us with its three largest counterparties in terms of payouts. It responded: “We do not make this information public.” We responded to that communication as follows:
“Freddie Mac is currently, as you know, a ward of the taxpayer with a lifeline to the taxpayer’s pocketbook via the U.S. Treasury.
“I’m a member of the press who is keeping the taxpayer informed about the continuing Wall Street bailout.
“Both the taxpayer and the press have a right to know which Wall Street firms are receiving these massive sums from Freddie Mac.
“You have offered no legal basis to justify your refusal to provide this information.
“Upon information and belief, each of these key counterparties to Freddie Mac are publicly traded and the investing public has a right to know exactly how these publicly traded firms are earning their profits.
“It could, potentially, be a violation of securities law to withhold this information from shareholders of Freddie Mac and the shareholders of the counterparties that trade publicly.
“If you won’t supply this information, it will require me to file a FOIA with FHFA, which will burden me and the taxpayer further.
“On March 19, 2009, under President Obama’s orders, the Attorney General’s office issued detailed guidelines on how Federal agencies were to respond going forward to Freedom of Information Act (FOIA) requests. The guidelines instructed the agencies as follows:
“ ‘The key frame of reference for this new mind set is the purpose behind the FOIA. The statute is designed to open agency activity to the light of day. As the Supreme Court has declared: ‘FOIA is often explained as a means for citizens to know what their Government is up to.’ NARA v. Favish, 541 U.S. 157, 171 (2004) (quoting U.S. Department of Justice v. Reporters Comm. for Freedom of the Press, 489 U.S. 749, 773 (1989)…The President’s FOIA Memoranda directly links transparency with accountability which, in turn, is a requirement of a democracy. The President recognized the FOIA as ‘the most prominent expression of a profound national commitment to ensuring open Government.’ Agency personnel, therefore, should keep the purpose of the FOIA — ensuring an open Government — foremost in their mind.’
“Since Freddie Mac is a ward of the government, I think you should also place a high priority on the ‘national commitment to ensuring open Government’ and provide me with this very basic information.”
As is typical with our “transparent” government, we have heard nothing further. (See related articles below.)
This is all starting to sound very similar to Wall Street’s other heist of the century: selling derivatives known as interest rate swaps to states, counties and municipalities that locked the taxpayer into paying Wall Street banks tens of billions of dollars as a result of Wall Street cratering the U.S. economy and driving down interest rates. As we previously reported in 2012:
“In March 2010, the Service Employees International Union (SEIU) issued a report indicating that from 2006 through early 2008 banks are estimated to have collected as much as $28 billion in termination fees from state and local governments who were desperate to exit the abusive interest rate swaps. That amount does not include the ongoing outsized interest payments that were and are being paid. Experts believe that billions of abusive swaps may be as yet unacknowledged by embarrassed municipalities.
“In 2009, the Auditor General of Pennsylvania, Jack Wagner, found that 626 swaps were done in Pennsylvania between October 2003 and June 2009, covering $14.9 billion in municipal bonds. That encompassed 107 of Pennsylvania’s 500 school districts and 86 other local governments. The swaps were sold to the municipalities by Citibank, Goldman Sachs, JPMorgan and Morgan Stanley.
“In one case cited by Wagner, the Bethlehem Area School entered into 13 different swaps, covering $272.9 million in debt for school construction projects. Two swaps which had concluded at the time of Wagner’s investigation cost taxpayers $10.2 million more than if the district had issued a standard fixed-rate bond or note and $15.5 million more than if the district had simply paid the interest on the variable-rate note without any swaps at all.”
Which brings us to the final question: when is a sharp-eyed financial expert with no ties to Wall Street going to carefully evaluate why Freddie Mac and Fannie Mae have not unwound these derivatives. According to Freddie and Fannie’s own SEC filings, they are already managing interest rate risk by issuing short and long term debt while also making various amounts of the debt callable and non callable.
When there are 6,000 banks in the U.S. but only five of them are compelled to hold over 90 percent of hundreds of trillions of dollars in derivatives, it’s time for the American people to demand and receive cogent answers. That is unlikely to happen without the political revolution that Senator Bernie Sanders is calling for.